Investor John enters into a seven-month forward contract on a dividend-paying stock when the stock price is $40 and the risk-free rate of interest is 5% per annum with continuous compounding. The stock will pay a dividend of $1.50 per share in three months. Calculate the theoretical forward price of this stock. If the actual forward price is $42, is there an arbitrage opportunity for John? Show in detail how John can earn a profit. How much is this profit on a per share basis?
Investor John enters into a seven-month forward contract on a dividend-paying stock when the stock price is $40 and the risk-free rate of interest is 5% per annum with continuous compounding. The stock will pay a dividend of $1.50 per share in three months. Calculate the theoretical forward price of this stock. If the actual forward price is $42, is there an arbitrage opportunity for John? Show in detail how John can earn a profit. How much is this profit on a per share basis?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Investor John enters into a seven-month forward contract on a dividend-paying stock when the stock price is $40 and the risk-free rate of interest is 5% per annum with continuous compounding. The stock will pay a dividend of $1.50 per share in three months.
- Calculate the theoretical forward price of this stock.
- If the actual forward price is $42, is there an arbitrage opportunity for John? Show in detail how John can earn a profit. How much is this profit on a per share basis?
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